July 21, 2020

Is Substack a Media Company or a Technology Company?

These days, it seems every media company wants to be a technology company (and shouldn’t be) and every technology company thinks they can be a media company. And then you have companies that are solidly in the middle—intentionally or unintentionally.

Substack is one of these companies. Although the company says it is a platform, recent decisions have started it down the path of becoming a quasi-media company. Case in point? The announcement of the Substack Defender program:

For the last few months, we have been piloting a legal support program for independent writers on Substack. As part of this program, we have been working with first-rate media lawyers to provide free advice and direction to writers who are facing legal uncertainty or pressure because of their work. This support has included pre-publication legal review of individual stories and responses to cease-and-desist letters. As of today, we’re making this legal support program more widely available. 

Recently, for instance, a high-powered lawyer representing a politician threatened a Substack writer for his coverage of the lawmaker’s questionable business ties. The threats disappeared when the writer, backed by our support program’s lawyers, stood his ground. At Substack, we want to make it crystal clear that anyone who uses such intimidation tactics will also have to reckon with us. We will use our financial and legal resources to vigorously oppose any bad-faith efforts to dissuade Substack writers from doing their work. 

Now look… I think this is an incredible initiative. It was only a few weeks ago, in my piece, The Creator/Operator Economy Still Needs More Empowering and Support, that I wrote:

Both health and libel insurance are policies that are cheaper to purchase when multiple people are doing it. That’s why small companies use professional employer organizations like TriNet. With tens of thousands of employees in the PEO, the cost for insurance drops per person.

This is the second thing Substack could do. If there was a way for people to buy this insurance as a group, the costs would drop and creator/operators could get better protection.

Substack says that it will cover legal fees up to $1 million. Something to consider is that this is something that a media company would do.

As we saw in Bollea v Gawker, an incredibly wealthy person (Peter Thiel) backed Hulk Hogan in his law suit against Gawker, which resulted in Gawker filing for Chapter 11 bankruptcy. This remains the biggest risk to any individual creator and Substack giving legal protection is encouraging. Of course, Substack has given itself an out by saying they get to choose which cases they support, so we’ll have to see how this new service actually plays out.

Further in the announcement:

We will make a large investment in a services program that includes initiatives related to healthcare, personal finance, editing, distribution, design, and coworking spaces. In our view, being independent shouldn’t mean being alone. 

These efforts to build services for writers will be a central part of Substack’s operations on an ongoing basis. We will continually improve this aspect of our work and welcome feedback and inquiries about potential cooperation. 

Check each of those off the list of things that media companies have historically offered to employees. With Substack looking to offer those services to creators, the concern some writers have about going out on their own goes away. I know that many writers might be willing to make the jump if they had healthcare taken care of.

Why do I bring all of this up?

All of these services cost Substack money. When you’re strictly a platform, you have the advantage of economies of scale as your business grows. If we want to create more content, we need more people. If Substack as a pure-play platform wants to support another 1,000 newsletters, it can do it without its costs growing linearly. Introducing a new feature can be spread across multiple newsletter writers. Media can benefit from that—look at The New York Times—but not to the same degree.

But if Substack starts to offer services like healthcare, editing, design and the list goes on, how does that get paid for?

I suppose Substack could simply build the tools to allow people to buy the resources they need without fronting any of the cost. Rather than being responsible for the costs, it simply provides the marketplace for people to buy. It could even go so far as to take a cut from all the services. If that’s the case, creators are in for a rude awakening because, unlike a revenue share, those costs are not proportional to your revenue. In other words, health insurance is a flat cost irrespective of how much you earn.

Another assumption would be that the revenue share—10% as of today—would cover it. However, if Substack does help cover some of it with the fee, then that’ll start to significantly eat into margins. Additionally, the company starts to look more and more like a media company rather than a platform.

There’s one reason why this is not a great play for the company. Presently, Substack is valued as a technology company. That means if it ever decides to sell or go public, it will most likely be treated as a SaaS company. The multiples on SaaS companies are significantly greater than on media companies. Let’s play it out…

Andreessen Horowitz (a16z) led a Series A of $15.3 million. Assume they bought ~15% of the company, which would value the company at, for easy math, $100 million. Most VCs don’t like “lifestyle businesses,” which are otherwise known as companies that can’t become billion dollar companies. Therefore, we can assume that a16z sees the company one day being worth $1 billion (10x return on investment).

According to the SaaS Capital Index, the median public company valuation multiple (on revenue) is ~11x. Over the past couple of years, it has been rising and falling between 8x and 11x, so let’s just say 10x for my continued easy math.

Now let’s look at media companies. We don’t get the same kind of multiples. It’s a few years old, but I found this article by Dorian Benkoil and Rafat Ali helpful:

A lot of discussions around a media company’s valuation start with a multiple of its revenue. Digital media companies tend to sell for between 2.5 and 5 times (2.5–5x) revenues from the previous, or “trailing,” 12 months.

Buyers, not surprisingly, are motivated by how much money they believe the company is going to make. Looking ahead, prices paid tend fall between 3–7x the predicted forward revenues for the upcoming 12 months.

Let’s say that Substack continues down the path of offering and paying for services that would have traditionally been offered by a media company. If investors start to value it like a media company, the accepted multiple might only be 5x revenue. The thing is, being valued at revenue might even be a stretch for media companies (though the investors on this email list would have to tell me what valuations they tend to see).

Here’s how that plays out to hit $1 billion in valuation:

  • Tech company: At a 10x multiple, Substack would need to generate $100 million. That would be 10% of $1 billion in total revenue across the network of newsletters.
  • Media company: At a 5x multiple, Substack would need to generate $200 million. That would be 10% of $2 billion in total revenue across the network of newsletters.

Are these possible targets? Likely. But for context, it took Patreon 6 years to payout a total of $1 billion to its creators. I do anticipate this sort of creator economy speeding up, but for Substack, it is imperative it keep itself solidly in the tech company sphere.

Why do I write this to a bunch of media operators? As Substack introduces additional features, offers fellowships, insurance and other services, it starts to become a competitive option for those journalists that have already built a large following. Perhaps most journalists don’t feel like this, but there is something to be said for having ownership in something. If Substack does start to track closer to becoming a media company, companies will need to start becoming more collaborative with their star people. What could that look like?

In my 2020 predictions (some that will likely be wrong), I wrote:

The second path, which I would love to see, is established publishers starting to incubate these newsletters. If your top journalist comes to you and says she’s going to leave because she want to launch a paid newsletter on Substack, wouldn’t it be better to try and keep her and her newsletter?

Essentially, you’d be going into business with an employee. The newsletter becomes almost co-owned by the media company and the journalist. The journalist provides the expertise and the writing; the publisher provides the operational support and a far larger audience. You split the revenue.

It’s a change to how we think about our businesses and media doesn’t typically evolve very quickly, but it’s worth starting to think about it.

Before I leave this topic, let me just say one final thing… I do actually commend Substack for creating these tools. It costs money. But if they’re really going to create a “new media ecosystem,” it’s going to come with inherent costs. And those might push it too far into the media company realm versus the platform.

Let’s talk about Idaho

Moving away from Substack, I want to talk about Boise; specifically, a media company called BoiseDev.

Don Day, the publisher, wrote a piece talking about the growth of paying members using a tactic other than a paywall.

So I came up with something we call a time wall. It launched about 18 months ago. It features a selection of our stories are available to members first, but later to the greater public (usually within a few hours). This gives a tangible benefit to members without locking everyone else out. It also eliminates that anticipointment factor. The stories are invisible to non-members until they are released. We don’t do this on every — or even most- stories, but it adds value.

He refers to anticipointment as the paywall “paired with a clickbait or leading headline … in that, you see something, anticipate it… then are disappointed.”

The time wall is an interesting approach to the business. Time becomes the difference between what you can or can’t see. You’d think that people wouldn’t pay since they only have to wait a few hours, but it’s clear that’s not the case.

Now, it’s only 800 paying subscribers after 18 months. But we shouldn’t discount the fact that this is making it possible to run a media business that reports on the business news in Boise.

Consider this… According to the living wage calculator at MIT, the average salary for someone working in media that lives in Boise, Idaho is $35,038. 800+ people paying $110 a year is $88,000. That would cover the salary of 2.5 employees at that revenue.

Like any good diversified media business, he also runs advertising on the site. But unlike many of those large local newspapers that are horrible to look at, he’s taken a different approach.

The business model, despite the large corps of paying members, still relies on advertising. But we’ve tried to do it a different way. Instead of endless ad trackers and programmatic ad units all over — every single ad on our site features a local advertiser, who I worked with directly. They include many top-line brands in our market. And each story page includes just four ad units.

Local is hard. It’s impossibly hard. But what Day has figured out is crystal clear. If you cover your market and provide information that matters, which means no national news or “mugshot galleries, crime, car crashes… even a weather report,” then you can build an audience. Some of that audience will pay. And in this attention economy that we’re working with, if you have the local audience, advertisers will also sponsor.

BoiseDev may never become a multi-million dollar business, but it’ll grow. And perhaps it’ll even add more staff. To sum it up in Day’s words:

Most importantly, this local news mission is driven by those 800 members — as well as members of the community who read our content and are not currently members. We work to bring them actionable, lively, exclusive stories day in and day out. Because every community deserves local news.